Dynamic strategies for fixed-income investment

The last 30 years have witnessed an enormous growth in fixed-income markets. How long-term fixed-income strategies should be implemented for the welfare of investors has become a major concern of bond managers. This study makes use of stochastic optimal control to formulate a multi-period portfolio selection model and implements it using backward recursion algorithm to find numerically the optimal allocation of wealth between long-and short-term bonds for an investor with power utility and an investment horizon of 10 years. By way of a technical manipulation, this study uses the fact that the long rate and the spread ( difference between long rate and short rate) are uncorrelated to simplify model formulation and parameter estimation. The results show that an investor would increase his/her holding of short-term bond if his/her investment horizon becomes shorter or if he/she is more risk averse, or both.